Opinion: You don’t have to be a mega-mind to get this trade right

Mega-cap stocks aren’t fashionable, but if you want to make money, there’s plenty of room in the space to do so.

By

JimLowell

Editor of The ETF Trader

New York (MarketWatch) — For years, good returns have come in smaller-cap packages. Now, with small- and mid-cap stocks looking like they’re at the higher end of their historical valuations, and most major market averages posting so many successive record highs that a kind of indifference to them has some wagging a market-crash finger. Investors are right to wonder if there are any bargains left on the shelf.

There are.

But you will find them, just where you would last think to look: Right in front of you, hiding in plain sight, as big and bold as the global brands they broadcast.

Mega-cap stocks, stocks in the upper-capitalization deck of the S&P 500, the biggest gorillas in the market’s cage, are not only the currently most attractive group of U.S. stocks by historical valuation standards, they’re also the most attractive group in terms of return potential.

On the one hand, I’d argue that the battleship behemoths have been shunned for swifter shuttles to faster gains — there’s nothing sexy about owning GE
GE, +2.89%
Microsoft
MSFT, -0.35%
or Bank of America
BAC, -0.82%
Even owning Apple
AAPL, -0.11%
feels like it’s such an obvious pick, that many of its kindred capitalization fruits have been left hanging on the tree.

Another reason: The rush to dividend yield may have netted some mega caps in the mix, but predominantly yield chasers rushed past the safer, more-liquid, less-volatile names en route to dividend yields they, too, could brag about.

I don’t know how else to say this. Mega-cap stocks aren’t fashionable: They have all the allure of a dinosaur. You’d have to be a cave man to think that by investing in such names you’d have any bragging rights at the stock-pickers’ performance bar. Besides, not to throw stones, but they haven’t performed as well as their smaller- and mid-cap brethren throughout this remarkable multi-year bull run.

I grant you that. But perhaps that is one reason you should consider them here and now. Their better valuations are in part a result of lagging, not leading, the run. Their lag is in part due to another factor: Mega-caps tend to derive the lion’s share of their revenue from the global marketplace. Relative weakness in the euro zone and Asia have meant that their profits have been more constrained, but are also better poised to claw their way higher if global recovery can trump geopolitical snafus.

Will the markets kowtow to geopolitics? Will the markets revert to the statistical mean of at least a 10% correction?

Who knows? No, you don’t. No. You don’t know either.

I do know that we have already begun to see the blush come off the small-cap rose (not permanently, not exclusively, but uncontestably). If, as I have written abut here several times this year, we get a now-statistically long overdue correction for larger-cap markets (a pullback of 10% to 15% wouldn’t surprise me), then I’d suspect we’d see a 15%-to-20%-plus swoon in smaller cap, the Russell 2000 kinds of names and indexes, which brings me to another thing I like about mega caps: Cash in their coffers. Many U.S. mega caps have better balance sheets than the G7 nations. They can weather a downturn better, and, hence, be better positioned to turn a correction’s lemons into profitable lemonade.

Since we’re talking about the elephant in the market’s room, I’m going to note three ways to lead them to this bull market’s circus.

Second, better than the above recommendation and the best pick for my money (and I do own this fund personally, as do clients at Adviser Investments), is Fidelity MegaCap Stock
FGRTX, +0.00%
Managed by veteran mega-cap stock picker Matt Fruhan, and backed by the unparalleled-research scope and scale and analytical acumen of Fidelity’s team, you’ve got a no-load, actively managed way to zero in on the potential sum gain of mega caps. Currently, Fruhan’s top picks include Apple, Bank of America, Comcast
US:CMCSK
Chevron
CVX, -1.65%
GE, JPMorgan Chase
JPM, -1.13%
Microsoft and Verizon
VZ, +0.08%
His top 10 represent 30% of the fund’s total holdings.

If I were thinking of trading into either, I’d also consider a third sector-investment trade into health care: pharmaceuticals. I want to be overweight health care generally, and in the mega-cap space, this, too, holds true. Given that neither of my mega-cap picks above are overweight mega-cap health-care names, I’ll inject them here: The iShares Dow Jones U.S. Pharmaceuticals ETF
IHE, -0.14%
or the more actively managed index of the Powershares Dynamic Pharmaceuticals ETF
PJP, -0.05%
I prefer the actively managed, no-load Fidelity Select Pharmaceuticals
FPHAX, +0.00%
to either for both a short-term trader and long-term investor. But if trading is raison d’etre, then I’d opt for PJP.

I know none of these picks will give you a story to tell in the “what’s hot that you’ve bought” conversations, but they should help you avoid having to recount nightmares … and provide cool-headed gains by year-end.

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